The Australian dollar rose to a month-long high overnight, hitting 71.88 cents against the US dollar. The surge came amid growing suspicions the Fed may have to keep interest rates on hold for the rest of the year.
US interest rates have an inverse relationship with international currencies. When rates rise, they tend to increase demand for the US dollar. This has the knock-on effect of dragging on international currencies as well.
Central bankers, at the RBA and elsewhere, don’t mind this one bit. In fact, their monetary policies rely on US interest rates boosting the greenback. Anything that strengthens the US dollar is a boon to their national currencies too. It helps boost exports and tourism, offsetting shortfalls in other areas of the economy. Better known as currency wars…
Anyway, back to the Aussie dollar for a minute.
Yesterday’s gains could’ve actually been even better. Were it not for weak domestic trade figures, the dollar may have edged above 72 cents. Australia’s trade deficit blew out to $3.5 billion in December. That sent the Aussie dollar to 70 cents in earlier trade yesterday. That it then managed to climb as high as it did is telling. It shows the influence US interest rates exert over global currency markets.
Looking ahead, the Aussie dollar’s future will depend on circumstances in the US. That doesn’t apply strictly to interest rates, either. How the US economy fares will have bearing on this too. Of course, these factors don’t function in isolation from each other. The fate of the US economy will also determine what the Fed does with interest rates.
Yet anyone (say, the RBA) pinning their hopes on rising US interest rates may be waiting a while. The Fed has its hands tied by an economy that’s best described as ‘plodding’. Recent economic indicators have been either disappointing, or well below expectation.
Service sector activity dropped to its lowest rate since February 2014 last month. That’s important as the sector accounts for two thirds of the entire US economy. This dip raises questions about whether the US economy is capable of recovering on its own.
Markets are also keeping an eye on US unemployment figures due this Friday. This’ll give us a better idea of what the Fed plans are for its short term rate policy. Bloomberg economists believe the number of jobs grew last month. But it’s expected to be the lowest monthly pace of growth since September. Combined with the oil price rout, the likelihood of a rate rise looks a distant prospect. Markets are even starting to price in the next hike as late as mid-2017.
Moving away from the USD for a moment, the Aussie was up against other major currencies. As at 10:30am AEST, one Aussie dollar was buying:
- 61 US cents, up from 70.21 cents on Wednesday
- 46 Japanese yen, up from 83.96 yen
- 57 euro cents, up from 64.34 euro cents
- 08 British pence, up from 48.72 pence
- 07 NZ dollars, up slight from Wednesday
Where to next for the Australian dollar?
US interest rates are expected to remain 0.25–0.5 past March at the earliest. In the short term, that should raise demand for higher yield currencies like the Australian dollar.
The ‘positive’ for the RBA is that long term price forecasts for commodities remain weak. Both oil and iron ore have spiked in recent weeks. Yet it’s unlikely that we’ve seen the end of the oil price crash. Analysts still expect the commodity to hit a floor of US$20 a barrel this year. The forecast are even worse for iron ore, which could remain caught up in a cyclical downturn for years.
So there are two forces at play here influencing the dollar’s movements. On the one hand, poor economic data in the US will continue to push the Aussie dollar higher. At the same time, commodity prices and weak global demand are having the opposite effect.
In part, these factors help explain why the dollar is stuck in a band between 68 and 72 US cents. It moves up and down depending on market sentiment that shifts on every new positive or negative data.
However, the likelihood of a global downturn dragging on through 2016 is bigger than a recovery. China’s slowdown, commodity prices, emerging economy struggles, the US economy, interest rates, housing crash…you name it. There are many, many reasons to be sceptical of a recovery taking root this year.
Because of this, it’s hard to see the dollar going anywhere but lower in 2016. How much lower? That depends on how slowly the global economic recovery plods along.
It wasn’t that long ago the Aussie dollar was trading as high as $1.10 against the greenback. Yet it’s lost 45% of its value since September. The value of the dollar could drop much quicker than most people expect.
The Daily Reckoning’s Greg Canavan believes a lower dollar is only the start. Everything up to now has been a snapshot of a bigger crash. Greg predicts the dollar could plummet as low as 50 cents against the greenback.
You’d imagine the RBA would be pretty happy about that. But you might not be. It will devastate the purchasing power of Aussie consumers. You’ll find shopping on Amazon becoming more and more expensive. And you might have to put off your holiday trip for that little bit longer.
But that could just be the beginning.
Greg says there are far more painful economic woes in store for Australia as the dollar hurtles lower. Factors that could do serious damage to your portfolio and wealth. You won’t hear the mainstream press talking about this. They’re too busy holding on to the hope that we can still steer our way out of this mess.
But you don’t have to be a victim of the dollar’s crash. There are steps you can take right now to protect your wealth. In a brand new Daily Reckoning report, Greg will show you why the dollar crash is now inevitable. He’ll reveal a unique ‘crash protection’ investment to shield your wealth from the fallout. To download the report, ‘Why the Aussie Dollar Will Crash in 2016’, click here.
Junior Analyst, The Daily Reckoning